Who or What Started Depression

8/8/2019 Who or What Started Depression

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What - or Who - Started the Great Depression? $

Lee E. OhanianUCLA and Federal Reserve Bank of Minneapolis

Abstract

Herbert Hoover. I develop a theory of labor market failure for the Depres-

sion based on Hoovers industrial labor program that provided industry with

protection from unions in return for keeping nominal wages xed. I nd that

the theory accounts for much of the depth of the Depression and for the

asymmetry of the depression across sectors. The theory also can reconcile

why deation/low nominal spending apparently had such large real effects

during the 1930s, but not during other periods of signicant deation.

Key words:

Great Depression, Herbert Hoover, Unionization, Deation

$ I thank Monique Ebel, Robert Himmelberg, David Levine, Nelson Lichtenstein, Fab-rizio Perri, Albrecht Ritschl, Jean-Laurent Rosenthal, and Rob Shimer for helpful discus-sions. Very special thanks to Bob Lucas, Ed Prescott, Nancy Stokey, and two refereesfor detailed comments on earlier drafts of this paper, and to Hal Cole for joint work onthe topic of union hold-up. Giang Ho, David Lagakos, Ruy Lama, and Paulina Restrepo

provided excellent research assistance. The views expressed herein are those of the authorand not necessarily those of the Federal Reserve Bank of Minneapolis or of the FederalReserve System.

Email address: [email protected] (Lee E. Ohanian)

Preprint submitted to Journal of Economic Theory July 29, 2009


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JEL Codes: E3, J3, N1

1. Introduction

Hours worked per adult in the United States were more than 20 percent

below normal throughout the 1930s. Many economists agree that this large

and persistent employment decline is the dening feature of the Great De-

pression, and characterize this as a chronic excess supply of labor reecting

a persistent and large labor market failure. Cole and Ohanian [1] develop a

theory of labor market failure for the post-1933 depression, based on Pres-

ident Roosevelts New Deal labor-industrial policies. These policies raised

real wages substantially above market-clearing levels which in turn kept em-

ployment and output low. But there is no theory of labor market failure

prior to the New Deal. This paper develops such a theory, and quanties its

contribution to the earlier stages of the Great Depression.

The theory is based on President Hoovers industrial labor program, in

conjunction with the growing power of unions. In November 1929, Hoover

met with the leaders of the major industrial rms and presented his plan to

deal with a possible recession. He told them that at a minimum, they should

not cut wages, and preferably would raise wages. He also advised them to

share work among employees. In return for maintaining or raising wages and

for work-sharing, Hoover told industry that he would keep union demands

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at bay. Following his conference with industry, Hoover secured organized

labors agreement to withdraw demands for higher wages and not to strike.

The largest manufacturers very publicly advertised their compliance with

Hoovers wage program by either raising nominal wages or keeping nominal

wages xed at their 1929 levels, and by signicantly spreading work among

employees. There was very little new union organization or strikes during

this period.

By late 1931, real manufacturing average hourly earnings had increased

more than 10 percent as a consequence of the Hoover program and deation.

By September 1931, manufacturing hours worked had declined more than 40

percent, and the average workweek in manufacturing had declined by about

20 percent.

To evaluate the quantitative impact of Hoovers program, I calculate the

equilibrium of a model economy with rms paying the observed real wage

in the industrial sector and following the observed workweek. I nd that

Hoovers program substantially depressed the economy, reducing aggregate

output and hours worked by about 20 percent. But why would rms be

willing to follow the Hoover program? Because in return for paying high

wages, Hoover offered protection from unions at a time when rms deeply

feared unionization and when court decisions and unionization policy - in-

cluding policies advanced by, and signed into law by Hoover - substantially

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increased the likelihood of organization and raised union bargaining power.

To assess this union protection hypothesis, I extend the model to include the

possibility of union organization that is similar to Cole and Ohanian [1], but

differs in that it is tailored to capture the central feature of unions at that

time, which was the ability to strike and extract rents from capital. I use

the model to quantify the benets of union protection, and nd that it was

indeed plausible that rms would follow Hoovers program.

This research complements a large body of work on the Depression, in-

cluding Friedman and Schwartz [2], who tie the Great Depression to a decline

in nominal spending and deation. This long-standing view, however, re-

quires a theory, but as Lucas (2007) notes, the development of such a theory

remains a challenge, precisely because it requires rationalizing such a large

and persistent monetary nonneutrality (see Parker [3]). This paper provides

such a theory through Hoovers industrial labor program, which raised real

wages in conjunction with deation.

The outline of the paper is as follows. Section 2 presents data, with a

focus on comparing the industrial sector, which was distorted by Hoover, to

the agricultural sector, which was not impacted by Hoovers program. Sec-

tion 3 summarizes Hoovers views on wages, unions, and industrial carteliza-

tion. Section 4 describes Hoovers labor program and how industry followed

it. Section 5 describes the incentives for rms to follow Hoover. Section 6

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presents the benchmark model, and the impact of Hoovers program on the

Depression. Section 7 extends the model to include a union that can hold-up

capital to quantify the benets for rms to follow Hoover. Section 8 discusses

the paper in relation to the broader literature, and discusses the contribution

of the paper as developing a monetary theory of the Depression. Section 9

concludes.

2. The Depression under Hoover: Low Employment and High Wages

This section presents data that highlight the severity of the industrial

contraction, the industrial labor market failure, in which low manufacturing

employment coincided with high wages, and also present data that contrast

the industrial sectors signicant decline with the much milder decline in the

agricultural sector, which experienced no labor market failure. I focus the

analysis from late 1929 to late 1931, the period in which Hoover has the most

inuence on industry.

I begin by presenting data on industrial economic activity. Figure 1 show

monthly manufacturing hours worked and manufacturing output (source:

NBER macro history database). At this time, manufacturing accounted

for about 28 percent of employment. These data show that the industrialdepression begins abruptly and severely in late 1929. Specically, industrial

hours and output rise until Fall, 1929, but decline rapidly afterwards. Hours

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and output fall 20 percent by June, 1930, and by roughly 40 percent by Fall,

1931. Figure 2 decomposes manufacturing hours into changes in employment

and changes in the length of the workweek, as both decline signicantly.

Employment declines by about 30 percent over this interval and the workweek

declines by about 20 percent.

Note that these data paint a very different picture from the standard

view that the Great Depression was initially a garden variety recession

(see Eichengreen and Bordo [4]). Instead these data show that the industrial

Depression was immediately severe and deep. In contrast, agriculture, which

accounted for about the same share of employment as manufacturing in 1929,

does not experience a drop in hours or real output. In fact, hours worked in

agriculture actually rise slightly between 1929 and 1931, increasing by about

1.5 percent. Real agricultural output rises by about 4 percent over this time

period (Kendrick [5], page 363-365).

These data show a remarkable difference in economic performance across

these two major sectors, and raise the question of why the Depression af-

fected these two sectors so differently. Real wage data suggest that a key

source for these differences lies in differences in the operation of their respec-

tive labor markets. The industrial depression coincides with a signicant

industrial labor market distortion, as real manufacturing wages rose during

the Depression. Figure 3 shows the nominal manufacturing wage, and the

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real manufacturing wage. 1 Real wages rise modestly at the start of the De-

pression, and continue to rise as the Depression deepens. The gure shows

that for much of this period, higher real wages are the consequence of roughly

constant nominal wages and deation. The industrial labor market distor-

tion is suggested by the fact that higher real wages coincide with substantial

employment loss. In sharp contrast, real wages fall considerably in agricul-

ture. The real agricultural wage, which is the daily farm wage rate relative

to the CPI, declines by about 25 percent between 1929 and 1931. (United

States Department of Agriculture, Statistical Bulletin Number 822, 1991)). 2

To provide further evidence of a large industrial labor market distortion,

I present data that indicates that households were signicantly constrained

in selling labor services in the industrial labor market, and I also summarize

data that indicates the supply price of labor was well below the industrial

wage. To show that households were constrained in selling labor services, I

rst note that in the absence of a labor market distortion, households should

have equated the marginal rate of substitution between consumption and

leisure to the real manufacturing wage. However, this implication is strongly

at variance with the data. Using preferences that are logarithmic between

1

I use average hourly earnings (Hanes, 1996) for the nominal wage, and construct the

real wage using the consumer price index.2 Agricultural hours and wages are available only at the annual frequency.

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consumption and leisure, and using data on consumption, hours worked, and

the manufacturing real wage, I nd that the manufacturing wage is about

30 percent higher than the marginal rate of substitution in 1931, which is

consistent with the view that the manufacturing wage was well above its

market-clearing level, and that households were rationed in selling their labor

services in industrial labor markets.

Data on the supply price of labor also indicate a large labor market dis-

tortion that prevented this market clearing. Simon [6] presents data on the

supply price of labor from help offered ads, in which individuals placed

ads in newspapers looking for work with a desired wage, and with a sum-

mary of their work characteristics. Simon shows that the supply price of

labor is as much as 40% below the wage paid, adjusting for selection and

quality. In contrast, the supply price of labor in help offered ads, and the

actual wage, were very similar just before the Depression, typically within a

couple of percentage points of each other. Simons evidence indicates that

the gap between the actual wage and the market clearing wage was not only

large, but that it did not respond to what clearly should have been very

strong competitive forces that should have reduced the wage and increased

employment. These data are also consistent with a substantial labor market

distortion which kept the industrial wage far above its market-clearing level.

This analysis suggests that the key to understanding the Depression is

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understanding and quantifying this labor market distortion. The next section

proposes a theory for this distortion based on Herbert Hoovers industrial

labor market program which, in conjunction with deation, fostered higher

real wages in the industrial sector, and which prevented those wages from

declining, even in the face of strong countervailing economic forces.

3. Hoover as a New Dealer

While Herbert Hoover is often portrayed as a market-oriented President,

some of his labor and industrial policies were thematically similar to Roo-

sevelts New Deal policies. Like Roosevelt, Hoover created policies that al-

lowed industry to cooperate in order to stem what he perceived to be the

depressing effects of cutthroat competition. And like Roosevelt, Hoover

believed high wages were the key to prosperity. Hoovers policies began in

the 1920s as Commerce Secretary. It is well documented that Hoover helped

create industry trade associations for the purpose of rm cooperation, includ-

ing sharing data on cost, output, and prices, and promoting standardization

of products. The central goal of trade associations was to prevent destruc-

tive competition, as Hoover, like Roosevelt argued that limiting competition

would lead to superior economic outcomes.The view that limiting competition was essential for economic prosper-

ity was inuential at this time, and was the result of the perceived success

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of World War I economic planning in which government, rather than mar-

kets, allocated production, and de facto limited competition by assigning

particular goods to be produced to particular producers (See Hawley [7], [8],

Himmelberg [9], and Rothbard [10] for extensive discussions of Hoovers de-

velopment of trade associations and his views about competition). There are

many statements from Hoover on the benets of cooperative trade associa-

tions and limiting competition:

...In 1927 as Secretary of Commerce, I wrote the foreword to a bulletin on

Trade Association Activities in which I said: the national interest requires

a certain degree of cooperation between individuals in order that we may re-

duce and eliminate industrial waste, lay the foundation for constant decrease

in production and distribution costs, and thereby obtain the fundamental in-

crease in wages and standards of living. Trade Associations, like many other

good things, may be abused, but the investigation of the Department of Com-

merce shows that such abuses have become rare exceptions. Within the last

few years trade associations have rapidly developed into legitimate and con-

structive elds of the utmost public interest and have marked a fundamental

step in the gradual evolution of our whole economic life. No facts have come

to my attention which would cause me to change the opinions expressed at

that time, rather every development of industry renders trade associations

more essential to sound development of our economic system. (Hoover din-

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ner speech presented at the convention of the American Trade Association

Executives, source: htp://www.presidency.ucsb.edu/ws/?pid=22633)

In his Memoirs (1952), Hoover stated:

...the great area of indirect economic wrong and unethical practices that

spring up under the pressures of competition...the great eld of economic

waster through destructive competition, through strikes, , through failure of

our different industries to synchronize...I then described the possibilities of

using the multitude of associational activities ...to bring these ideas to reality,

we enlisted the different trade associations in creation of codes of business

practice and ethics that eliminate abuses. (Hoover [11])

There is considerable evidence that the trade associations facilitated the

collusion that characterized large industry in the 1920s. Kovacic and Shapiro

[12] discuss that trade associations were the central cooperative agency for in-

dustry at this time, that the Executive Branch discouraged aggressive prose-

cution by Department of Justice and the Federal Trade Commission, and that

the Courts also were inuenced by the limited competition view: Supreme

Court decisions in this era (1916-1936) affecting collusion and cooperation

between rms reected tolerant treatment...By the early 1930s, in the depths

of the depression, even the courts stand against naked horizontal output re-

strictions wavered. In Appalachian Coals Inc. vs. United States, the Court

refused to condemn an output restriction scheme embodied in a joint market-

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ing agreement proposed by coal producers... the Court appeared to have lost

faith in free market competition and welcomed experiments with sector-wide

private ordering. Epstein [13] reports that industrial prots, particularly

for large rms, were high during the 1920s, which is consistent with the fact

that capitals share of income in manufacturing rose substantially during this

period.

Hoover was also a strong supporter of unions and high wages. Hoover

emphasized in his Memoirs that he was delighted with the signicant growth

of union wages, which rose about 40 percent in the 1920s, compared to only

about a 6 percent increase for non-union wages (Bureau of the Census, 1976).

In his Memoirs, Hoover presented a table of U.S. union wages in the U.S. in

the 1920s, contrasted with real wages from the U.K., which had not advanced,

and remarked:

We could as a nation show one of the most astonishing transformations

in economic history, the epitome of which lies in the following table, com-

piled from the department of labor statistics...These gures demonstrate one

positive thing - the rapid increase of real (union) wages. A comparison with

British indexes gives evidence that these results are peculiar to the United

States., pp 77-78.

According to Hoover, high real wages were necessary to keep demand,

and in turn output, high:

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not so many years ago, the employer considered it was in his interest to

use the opportunities of unemployment and immigration to lower wages... the

lowest wages and longest hours were then conceived as the means to obtain

highest prots. But we are a long way on the road to new conceptions. The

very essence of great production is high wages...because it depends upon

a widening range of consumption only to be obtained from the purchasing

power of high real wages.... (p. 108, Hoover [11]).

Hoover was central in advancing unionization. He promoted and signed

landmark unionization legislation, including the Davis-Bacon Act in 1931 and

the Norris-Laguardia Act in 1932, both of which raised wages and facilitated

unionization. The Davis-Bacon Act requires that prevailing (union) wages

be paid on public works projects, and the Norris-Lauguardia Act prohibited

courts from issuing injunctions against union strikes, picketing, or boycotts

and also prohibited yellow dog contracts, which allowed rms to require

that workers sign a contract indicating that they will be red if they join a

union. After the National Labor Relations Act, the Norris-Laguardia Act is

considered by many as the second most signicant unionization legislation in

the United States.

Hoover also supported unions by intervening in industrial-labor relations

related to working conditions and the length of the workweek. The most

striking case of this was in the steel industry. Following unsuccessful attempts

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4. Hoovers Labor Program

In November, 1929, Hoover met with the leaders of the major industrial

rms in manufacturing, utilities, and transportation at the White House.

Hoover presented his program for raising wages and work-sharing to avoid

rm-labor conict that he anticipated would arise. Hoover informed industry

that they were to bear the cost of a recession by securing from them an

agreement to maintain or raise nominal wage rates, and to engage in work-sharing. In return, he secured an agreement from labor to not strike and

to not demand further wage increases. This program is clearly consistent

with Hoovers preferences for fostering high real wages, supporting unions,

and reducing the workweek. The meeting is described in Hoovers Memoirs

and by his Secretary of Commerce Thomas Lamont (1930). President Hoover

asked industry to maintain or increase current wages, as this would help keepthe industrial peace:

...to maintain social order and industrial peace...a fundamental view (is)

that wages should be maintained for the present...that the available work

should be spread by shortening the work week...the industrial representa-

tives expressed major agreement...the same afternoon I conferred with the

outstanding labor leaders and secured their adherence to the program...this

required the patriotic withdrawal of some wage demands... (Hoover [11], pp

43-44). Lamont noted One of the rst things which they (business leaders)

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did was to agree in principle to maintain the level of wages to perpetuate

industrial peace. 3

Hoover adopted this program not only because he believed it would reduce

conict between capital and labor, but also because it advanced his goal

of raising real wages. Hoover was particularly concerned that non-union

real wages rose much less than prots in the previous decade. Specically,

when industry broached the topic of reducing nominal wages in early 1931,

with industrial output dropping by more than 30 percent, Hoover rejected

the request, and gave no indication that wages should come down in the

future: Wages during Prosperity went no where near so high, comparatively,

as commodity prices, business prots and dividends; therefore they should

not come down with the general decline. (Time, April 13, 31). Similarly,

The White House rejected wage cutting requests in the Fall of 1931, and

The Department of Commerce warned that wage cutting would result in

labor unrest and Hell to pay all over the country, Time, October 5, 1931).

Hoovers program was ultimately aimed at systematically raising real wages

- particularly non-union wages - to reverse more than a decade of what he

perceived to be the disproportionate growth of capital income relative to

3

Rothbard [10] reports that industry requested additional government-industry co-

operation in return for agreeing to Hoovers wage program, though I have been unable

to nd other discussions of this.

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labor income.

4.1. Industry and Labor Followed Hoovers Program

Following their November 1929 meeting with Hoover, major industrial

rms either kept nominal wages xed, or raised wages, and spread work

considerably. The pattern of xed/rising nominal wages during a period of

deation and economic downturn differs remarkably from previous episodes.

To highlight this difference, I compare wages under Hoover to those during

the previous episode of signicant deation (1920-22), when the CPI declined

by about 20 percent. Ozanne [14] describes that International Harvester,

facing no threat of unionization in the early 1920s, cut wages by 20 percent

in April 1921 and an additional 12.5 percent in November 1921 for a total

wage reduction of about 30 percent. Aggregate data also indicate signicant

wage cutting in the early 1920s. Nominal earnings of full time manufacturing

workers fell about 19 percent between 1920 and 1922. (Bureau of the Census,

1976). These large nominal industrial wage cuts from 1921-22 stand in sharp

contrast to the relative xity of nominal wages under Hoover. 4.

4 The fact that the aggregate decline is smaller than that of the rm level data probably

reects the fact that the aggregate data are annual averages, that the aggregate data are

not adjusted for any compositional changes, and that the aggregate data also includes

some union wages, which did not fall as much.

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council in its report again expressed appreciation of my efforts and of the

substantial success. The AFL report noted in the full year of 1930 there

were only seven rms per hundred rms had cut wages. (page 46).

University of Chicago economist Jacob Viner also attributed high wages

to Hoover. The Hoover Administration became apostles of doctrine that

high wages are an essential of prosperity...Hoover pledged industry not to cut

wages, and for long time large-scale industry adhered to pledge, (OBrien

[16]) . This view was echoed by Commerce Secretary Andrew Mellon, who

noted there has been a concerted and determined effort on the part of

both government and business...to prevent any reduction in wages. Time

Magazine noted The United Press International interviewed business leaders

who attended the 1929 White House conferences, discovered an agreement

among them that Industry, by & large, had lived up to its wage pledge.

Pierre Samuel Du Pont (I. E. du Pont de Nemours & Co.), Walter Sherman

Gifford (American Telephone & Telegraph). Jesse Isidor Straus (R. H. Macy

& Co.) declared their companies had not reduced their wage scales since

1929. Walter Clark Teagle said his Standard Oil of New Jersey had found it

necessary to cut workers weekly earnings by part-time employment but that

the base pay rate had been maintained. (Next: Wages?, 4/13/31, Time,

pp 12-13). Most of the major manufacturing rms that publicly advertised

and veried their compliance with Hoover were not unionized at the time,

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including Bethlehem Steel, Dupont, Ford, GM, Goodyear, and U.S. Steel.

This evidence suggests Hoovers independent inuence on wage setting among

large-scale industry.

Not surprisingly, the impact of high wages on protability caused consid-

erable concern among industrial leaders, who in January 1931 argued that

wage scales should be adjusted to price reduction...It is not true that high

wages make prosperity. Instead, prosperity makes high wages. (New York

Times, January, 1931, in Executive Opinion , Kroos [17]). Indianas Repub-

lican Congressman William Robert Wood, chairman of the House Appropri-

ations Committee, noted in 1931 that Either wages should come down or

commodity prices should go up. The wage level is far above the selling level.

(Next: Wages?, 4/13/31, Time, pp 12-13). Industrial wages clearly were

much higher than their market clearing level, and the evidence shows that

Hoovers program was responsible for the nominal industrial wage oor, and

for the substantially shorter workweek.

In return for industry following Hoovers program, labor largely kept their

pledge to Hoover to not strike, as man-days lost to work stoppages was at

its all time low in 1930 (U.S. Bureau of Census, [18]). Moreover, there was

little labor organization during this period. Freeman reports that union

membership as a fraction of non-agricultural employment fell between 1929

and 1931.

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Major producers followed this program until late 1931. At this time,

Hoover informed industry that he would not support the Swope program,

which explicitly provided for cartels, and which was a de facto blueprint for

the National Industrial Recovery Act. Following this, major manufacturers,

including U.S. Steel and G.M instituted their rst nominal wage cuts.

5. The Incentive to Follow Hoovers Program

The benet Hoover offered to rms for following his policy was implicit

protection from unions. This section provides evidence that the benet of

protection from unions was potentially large. To do this, I rst discuss the

signicant impact that unions had on wages at this time, I then discuss

how rms prior to Hoover could effectively prevent unionization, and I then

discuss how labor policies and court decisions changed substantially, which

permanently reduced rms ability to prevent organization. and which raised

the probability and cost of unionization.

5.1. Fear of Unions: High Union Wage Premia

It is widely agreed by labor historians that industry deeply feared unions

at this time, reecting unions ability to violently strike and extract high

wages. Firms viewed the strike as a weapon that unions used to appropriate

capital returns. Concern about unions and expropriation were sufficiently

prominent that it was the primary theme of the 1926, volume New Tactics

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in Social Conict, Harry W. Laidler and Norman Thomas, Editors), who

presented a symposium on industrial-labor relations, with the specic focus

on the conict between capital and labor: We are concerned by the struggle

which inevitably rises, no matter how it may be concealed,...over prots

(that) legally belong not to the hired worker but to the owners....in practice,

labor in America has tended to ght out this struggle in terms of brute

conict. Nowhere in the world has the labor struggle in time of strikes been

more bitterly fought than here in America.

One reason rms feared unions is because of a high and growing union

wage premium. Table 1 shows union and non-union wages (Bureau of the

Census, 1976). Nominal union wages rise about 40 percent over this period,

while non-union wages rise about 6 percent. 5 Microeconomic evidence is also

consistent with a large union premium. For example, in May, 1922, the union

rate for wood patternmakers in Chicago was about 40 percent more than the

wage paid for the same occupation by International Harvester and Western

Electric, both non-union shops (Ozanne [14]).

The perceived threat of unionization raised wages of non-union works

5 There is about a 55 percent difference between union and non-union wages this period.

Some of this difference may be due to factors other than union market power, such as

human capital differences in workers. However, I am focusing on the change in the premium

over the 1920s, and not the level of the premium.

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during this period. Ozanne noted that International Harvester gave out

wage increases only to buy off labor and prevent unionism, and did not

raise wages when unions were not perceived to be a threat. Firms that

feared unionization tended to pay higher wages. Union wage inuence was

felt through wage concessions by employers who feared being unionized. This

magnied many times the inuence of the rapidly growing unions. (Ozanne

[14], page 52). Economist Frederick Mills argued that the threat of unions

kept non-union wages from being any lower in the 1920s than they were

(Bernstein [19]).

5.2. Preventing unionization in the Early 1920s

There was a substantial incentive to keep unions out of the workplace, and

rms were largely successful in preventing unionization in the early and mid

1920s. Union membership declined from about 17.4 percent in 1921 to about

10.5 percent by 1929 (Freeman [20]). Preventing unionization was fostered by

Court decisions and government policies that limited the ability of unions to

organize and that favored rms during strikes. Ebel and Ritschl [21] summa-

rize Court decisions and how they signicantly impeded union organization.

There is considerable discussion of the limited ability of unions to organize

in the 1920s among labor historians, which I summarize here (Bernstein [19]

is a standard reference). Prevention methods included company unions and

modest corporate welfare programs that are widely perceived to have kept

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unions out of the workplace, and the use of violence when unions attempted

to organize or when workers called a strike. Gittelman [22], Ozanne [14],

and Jacoby [23] describe the use of company unions and welfare programs,

and Bernstein [19] describes rm violence during several union organization

attempts and strikes during the early and mid-1920s. These tactics included

kidnapping union organizers, ring workers who met with organizers, evicting

strikers from company-owned homes, denying medical care to striker families

from company-directed health providers, and beating and shooting strikers.

Firms were sometimes able to bribe local police, and also hired private police

forces that in some cases were deputized. Firm actions during strikes were

rarely prosecuted, but union actions were often prosecuted.

Large rms coordinated to prevent unionization. This included the Spe-

cial Commerce Committee, whose objective was rst and foremost...to ex-

clude unions from their plants. (Gitelman [22]). Ozanne [14] describes the

functions and activities of this Committee and using archival data also de-

scribes labor relations at International Harvester, which is considered to be

a representative member of the committee. Ozanne noted that the major

objective for International Harvester was that of blocking outside unionism.

(page 156) The Committee coordinated corporate welfare programs and com-

pany unions to help suppress unionism, and there is agreement that these

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programs were successful. 6 Wages were a central topic of Special Conference

Committee meetings. In fact, at the Committees meeting of March 20, 1931,

GM indicated that they were opposed to cutting wages, as was Bethlehem

Steel. Goodyear had maintained wages from 1929, but was considering a

wage cut. The major issue discussed at that meeting was how to deal with

union organizers following a wage cut.

5.3. A Sea Change in Labor Policies: Facilitating Unionization

Legislation and Court decisions on labor unions shifted substantially at

the end of the 1920s, and these changes signicantly aided union organization

6 The origin of the Special Conference Committee is that the largest industrial com-

panies did not want their employment and wage policies to become public, because they

felt that these policies would lead to antitrust prosecution. Bethlehem Steel, Dupont,

GE, GM, Goodyear, International Harvester, Irving Bank and Trust, Exxon, US Rubber,

Westinghouse formed the Special Conference Committee, and AT&T and US Steel joined

afterwards. The Committee had no telephone listing, no letterhead, no bank account,

no dues. The Committee met regularly for roughly two decades to discuss and collude

on labor relations, wage policy, and national and legislative movements to regulate labor

relations. There was one full-time employee, who would report on union activities at each

meeting. Wage policies were very similar across companies. The rst public knowledge of

this committee arose during the 1937 hearings of Senator Robert LaFollettes Civil Liber-

ties Committee, which was investigating abuses of civil and personal rights by industry.

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and the impact of unions. These changes are described by Ebel and Ritschl

[21], and are briey summarized here. Key legislation included the Railway

Labor Act, which was strongly supported by Hoover, and which made col-

lective bargaining at the company level mandatory in that industry. The

act provided for state arbitration in labor disputes, and virtually eliminated

the ability of rms to impose company unions, which had been a key factor

in preventing independent unions during the 1920s. Even more important

was that this legislation was upheld by District Court in 1928, the Court

of Appeals in 1929, and the Supreme Court in 1930. These judicial reviews

overturned many previous court rulings that had upheld employers rights

against unions.

There is considerable agreement that the Railway Act and subsequent

Court decisions were the genesis of legislation that facilitated unionization

and substantially increased labor bargaining power, including the Norris-

Laguardia Act of 1932, which prevented yellow dog contracts and which

reduced the use of injunctions against labor, and the Wagner (National La-

bor Relations Act) of 1935, which in its original form not only provided

for collective bargaining, but also placed very few limitations on labor ac-

tions during strikes. In addition to legislation and Court decisions, and to

Hoovers support of unions, the deaths of strikers by militia in the mid-1920s

not surprisingly led governments to signicantly reconsider its policy during

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strikes.

There is agreement that new union organization was ineffective during the

1920s, that this was an important component of low unionization rates at that

time, and that ineffective organization was largely the result of government

policies and Court decisions that favored rms. There is also agreement that

labor policies changed considerably in the late 1920s, that these changes

signicantly reduced rms ability to prevent unionization and more broadly

raised the threat and cost of unionization. This analysis thus indicates that

there were benets to following Hoovers program that provided protection

from unions in return for paying moderately higher wages. The next section

develops an economic model to quantify the impact of Hoovers program

on the economy, and to assess the relative benets of following Hoovers

program.

6. The Hoover Economy

Hoovers plan provided rms with protection from unions if industry

maintained/raised their nominal wages and spread work by reducing the

average length of the workweek. To quantify the contribution of this policy

to the Depression, I construct a general equilibrium model tailored to capturethe main features of the Hoover program. Since the Hoover program did not

affect all sectors, I construct a two sector model in which one sector is sus-

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ceptible to unionization and thus is affected by the Hoover program, and the

other sector is not susceptible to unionization and thus is not impacted by

the Hoover program. I will refer to these two sectors as manufacturing, and

agriculture, respectively, with the agricultural sector including agriculture

and other sectors in which potential unionization was less likely.

Time is discrete and denoted by t = 0 , 1, 2,... . There is a representative

household with many members, who supply labor and who consume a single

consumption good ( C ). Population grows at the constant rate n. Each of

these intermediate goods is a CES aggregate of output from an individual

industry within that sector. The output of industry i in sector s, s {a, m },

is denoted by ys (i), and is given by:

ys (i) = h(i)es (i) ks (i)1 ,

in which the length of the workweek is given by h, employment is given by e,

and capital is given by k. I use a technology with a variable workweek since

Hoovers program impacted the workweek in manufacturing. This specica-

tion has been used by Kydland and Prescott [24], Braun and McGrattan [ ?

], Hayashi and Prescott [25], Osuna and Rios-Rull [26] , and McGrattan and

Ohanian [27], among others. 7

7 Capital input in this model is variable, and is equal to the capital stock scaled by the

length of the workweek, or hours per worker. In the model, utilization falls in manufac-

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The aggregate intermediate goods, Y a and, Y m are given by:

Y s = 1

0ys (i)di

1/

. (1)

Production of the nal good, and the allocation between consumption

and investment is:

Y = m Y m + sY

a1/ (2)

Y = C + X (3)

Labor is mobile across sectors, but capital is specic to each sector. The

turing, which is consistent with actual manufacturing utilization during the Depression.

It is worth pointing out two issues about tieing the decline in utilization to hours per

worker. One is that some of the decline in utilization was due to plant closings, rather

than a shorter workweek across all plants. Another is that some worksharing was such that

workers were employed for fewer days, but the plant could have had the same workweek

length. I am unaware of data that can provide any type of detail on these distinctions,

however, so I will treat the model as a parsimonious tool for capturing low capital input

during the Depression, as it will allow the model to be consistent with actual manufac-

turing output per hour. This treatment is also reasonable because there is evidence that

worksharing that reduces the number of days an employee works, even keeping the length

of the workweek xed, also reduces output per hour (see Lanoie, Raymond, and Shearer

[28]).

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evolution of the capital stocks for manufacturing and agriculture is given by:

K st +1 (i) = (1 )K st (i) + X st (i), (4)

X st (i) 0 (5)

6.1. Household Problem

Each household member has one unit of time, and either works in the

agricultural sector, in the manufacturing sector, or engages in non-market

activities. Given a variable workweek in production, the household in the

benchmark model chooses the length of the workweek and the number who

work. The households problem is given by:

max

t=0

t {ln(ct ) + eat ln(1 hat ) + emt ln(1 hmt ) v(eat + emt )}(1 + n)t

subject to

t=0

Qt [wat eat + wmt emt ct ] + 0 = 0 , (6)

where Qt is the date t price of goods, ea is the number of household mem-

bers who work in the agricultural sector, em is the number who work in

the manufacturing sector, ha is the workweek length in agriculture, hm is

the workweek length in manufacturing, and 0 are date-zero prots. Note

that the opportunity cost of working includes not only hours worked for each

household member who works, but also includes a cost of sending household

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members to work, which is governed by the function v(ea + em ).To specify

this function, I assume that the cost of entering the workforce differs across

individuals in the family. Rank-ordering household members by their posi-

tion in the distribution of these costs, and specifying that these costs rise

linearly, I obtain:

v(eat + emt ) =

e t

i=0

(0 + 2 1x)dx = (0et + 1e2t )

This specication yields a strictly convex cost function for employment,

and thus implies a well-dened problem for the household in choosing both

the number of workers and the length of the workweek.

6.2. Final Goods Production

Production of nal goods, which is the numeraire, is competitive. The

problem for a representative nal producer is given by:

maxs

s 1

0yds (i)

di/ 1/

s

1

0 ps (i)yds (i)di (7)

where yds denotes the nal good producers demand for the output from

industry i in sector s. This problem yields the following efficiency condition

for the demand for intermediate inputs:

sY 1 Y s (y

ds (i))

1 ps (i) = 0 for all i and s = {a, m }. (8)

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6.3. Intermediate Goods: The Competitive Sector

The agricultural sector is competitive. There is a single technology that

is used to produce intermediate goods for consumption and for investment

goods in this sector. The output price is pa . The maximization problem for

a representative producer in industry i in the agricultural sector is given by:

maxeat (i) ,k at +1 (i)

Qt pat (i)hat (i)(eat (i)) kat (i)1

+(1 )kat (i)) wat eat (i) kat +1 (i)

+ Qt+1 [r at +1 (i)kat +1 (i)] ,

(9)

where r at +1 (i) denotes the return to capital earned in the industry in period

t + 1 . Note that r a is given by:

r at (i) = pat (i)(1 )hat (i)eat (i)kat (i)

+ (1 ). (10)

6.4. Intermediate Goods: The Cartel Sector

Manufacturing industries also provide intermediate goods for production

of consumption and investment nal goods. The manufacturing sector is mo-

nopolistically competitive. The maximization problem for a representative

producer in industry i in the manufacturing sector is given by:

maxemt (i),k mt +1 (i) Qt pmt (i)hmt (emt (i)) kmt (i)1

+(1 )kmt (i)) wmt emt (i) kmt +1 (i)+ Qt+1 [r mt +1 (i)kmt +1 (i)] ,

(11)

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where r mt +1 (i) denotes the return to capital earned in the industry in period

t + 1 ,and Q is the intertemporal price. Note that r m is given by:

r mt (i) = pmt (i)(1 )hmtemt (i)kmt (i)

+ (1 ) (12)

6.5. Parameterization

Several of the model parameters have values that are standard in the busi-

ness cycle literature. This includes the growth rate of technological progress,

which is two percent, the population growth rate, which is one percent, the

household discount factor ( ), which is chosen so that the steady state return

to capital is six percent, the exponent on capital in the production function,

which is 1/3, and the depreciation rate, which is ve percent annually.

I choose values for the utility function parameters , 0 and 1 to target

a steady state employment rate of 0.7, a steady state workweek length of

0.5, and that about 80 percent of the deviations in hours worked off of the

steady state growth path are due to changes in employment and about 20

percent are due to changes in the workweek length. This latter specication

is consistent with the relative contributions of changes in employment ver-

sus hours per worker to cyclical uctuations in total hours worked prior to

Hoovers program.8

8 The standard deviation of the log of manufacturing employment changes net of a linear

trend is about four times as large as the standard devation of the log of manufacturing

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In terms of the technology parameters, governs the elasticity of substi-

tution within a sector, and is set at 0.9, which implies about a 10 percent

mark-up in a standard monopolistic competition version of the model. The

parameter governs the substitution elasticity between goods across the

cartelized and non-cartelized sectors. I use a substitution elasticity of 1/2,

as in Cole and Ohanian [1]. This value is consistent with the facts that man-

ufacturings relative price and its expenditure share have declined over time.

I specify the sectors of the economy under the Hoover program as manufac-

turing, mining, construction, transportation, and utilities, which accounted

for about 40 percent of employment in 1929, and this species the value for

the share parameter .

6.6. The Hoover Depression

This section presents the perfect foresight equilibrium path of the Hoover

economy. To do this, note that the Hoover intervention is a unanticipated

and permanent change in the model, with the economy transiting afterwards

to the Hoover steady state.

I construct the Hoover economy using the model above, and by introduc-

ing two additional features. First, I specify that the manufacturing sector

pays the observed real manufacturing wage sequence from 1929:4-1931:4. The

workweek changes net of a linear trend. The source of the data is Kendrick [5], page 465.

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manufacturing wage is exogenous in the model, which I interpret as the prod-

uct of Hoovers xed nominal wage program in conjunction with deation.

The second feature is that the workweek in manufacturing is exogenously

xed at its actual sequence between 1929:4 - 1931:4. Hoovers worksharing

mandate is almost certainly the reason why the workweek declined so much

during the Depression. 9 As discussed above, before Hoovers intervention,

the workweek length varied little over the cycle, as changes in employment,

rather than changes in hours per worker, accounted for most of the cyclical

change in manufacturing hours. For example, following the World War I

demobilization, manufacturing hours declined considerably (falling about 25

percent between June, 1920 and December, 1921), but almost all of this was

due to lower employment, as hours per worker only fell about 3.5 percent

during this period. This cyclical stability of hours changed remarkably after

Hoovers intervention, with the workweek declining about 2/3 as much as

employment declined between late 1929 and late 1931. 10 .

9 Hoover intended his worksharing program to be a form of insurance against job loss.

However,recall that there was very little worksharing prior to Hoovers program. Presum-

ably, worksharing was always possible, and the fact that rms and workers did not choose

this option suggests that the benet exceeded its cost.10 The analysis could certainly be extended into 1932 and afterwards, as real industrial

wages remain above trend. I choose not to include later years, as it becomes clear during

1932 that Roosevelt will defeat Hoover. While Roosevelt expanded industrial and labor

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Computing the equilibrium path requires a terminal condition. I choose

the terminal condition to be the steady state of the Hoover economy, with

the manufacturing wage permanently above its competitive level. The per-

manent impact of the policy is consistent with the fact that labor policies

changed permanently under Hoover, and is consistent with Hoovers goal of

permanently raising real wages, particularly for non-union workers. I there-

fore choose the terminal condition as the steady state of the economy with

the industrial wage permanently equal to its trend adjusted value in 1931:4,

which was about seven percent above its 1929:3 value. 11 I treat the 1929:3

value as the market-clearing wage prior to the policy. I also specify the work-

week length in manufacturing to be permanently set to its 1931:4 level for

the terminal economy.

I rst calculate the steady state of the Hoover economy. Table 2 shows

these steady state values relative to the pre-Hoover steady state. Hoovers

program generates a substantial steady state drop in economic activity, re-

cartelization policies beginning in 1933, as analyzed in Cole and Ohanian [1], including

this factor would complicate the analysis.11 I am unaware of evidence that rms or policymakers expected wages to return to

(trend-adjusted) 1929 levels. Note that choosing a value for the terminal wage of 7 percent

above trend is a very conservative choice relative to the actual value of the manufacturing

wage that prevailed after 1931.

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ducing steady state output (Y), consumption (C), and investment (I) by

about 28 percent, and steady state total hours worked (H) by about 20 per-

cent. The decline in hours reects a 38 percent drop in steady state industrial

hours worked (H m ) and an eight percent drop in steady state agricultural

hours worked (H a ). The decline in agricultural hours reects a 30 percent

decline in the agricultural wage, which in turn reects a 20 percent decline

in the relative price of agricultural output. Thus, while workers can always

choose to work in the agricultural sector, the incentive to do so is reduced

substantially by the Hoover policy. This large change in the incentive to

work in the non-distorted sector operates through general equilibrium effects

created by the Hoover program.

To calculate the equilibrium transition path of the economy to the Hoover

steady state, I set the initial capital stocks at their pre-Hoover steady state

values. Figures 4 - 8 show the transition path of real output, consumption,

investment, and hours worked in the model, compared to the actual values of

those variables between 1929:4 and 1931:4. 12 The Hoover program depresses

the economy substantially, reducing aggregate hours by about 20 percent by

the end of 1931, and reducing real GDP by about 18 percent. The model also

generates a depression that is considerably worse in the manufacturing sec-

12 With the exception of manufacturing hours, the actual data are linearly interpolated

to the quarterly frequence.

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tor, as manufacturing hours decline 33 percent by 1931:4, while agricultural

hours fall by about 11 percent. Consumption is 12 percent lower in 1931:4,

while investment is 55 percent lower at this date. Note that investment rises

temporarily when the policy is adopted, which is due to two simplifying fea-

tures in the model. One is the perfect foresight assumption, and the other is

that there are no investment adjustment costs. While both of these features

create a very transient incentive to accumulate additional capital, invest-

ment in the model is below trend in late 1930, and falls quickly thereafter.

Including either time-to-build in the production of capital goods, or convex

adjustment costs would substantially dampen the transitory investment in-

crease. The workweek restriction is important as it allows the model to be

consistent with the fact that actual manufacturing output per hour does not

rise substantially. In particular, manufacturing output per hour is on aver-

age slightly higher during this period, and in the model is about 2 percent

higher.

To shed further light on the permanent impact of the policy on the econ-

omy, I compare these ndings to those of Cole and Ohanian [29], Table 9,

who studied the impact of the same real manufacturing wage sequence in a

similar economy, but assuming that the wage distortion was transitory, rather

than permanent, and with no workweek restriction. Amaral and MacGee [30]

also use a two-sector model with inexible manufacturing wages and exible

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agricultural wages to analyze the Depression as the result of a transitory

monetary shock. The impact of the high real manufacturing wage in both of

these analyses is much smaller than here, with real output falling only about

4 percent by 1931. This reects the fact that steady state hours and capital

are not depressed in these other analyses. 13 This suggests that quantifying

a depression of this magnitude in this class of models requires a permanent,

not a transitory, distortion.

7. Introducing a Union in the Model

This analysis assumes that rms followed Hoovers program because the

alternative of not following Hoover, but having to deal with the possibility

of union organization, was less protable. To assess this hypothesis, I extend

the model economy to include the possibility of union organization, which

I model in an insider-outsider framework. The union model is tailored to

capture a key feature of unions in the 1920s and 1930s, which is the ability

to strike and hold-up capital. It thus differs from Cole and Ohanian [1], in

which the insiders make an offer before capital is in place. In this model, the

insiders offer is made after capital is installed, thus creating the hold-up.

13 Bordo et al [31] generate a much larger depression from high wages, though their

analysis is in an economy in which all wages in all sectors are high, and the real wage

sequence they use is higher than the one used here.

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period: (wt , et ). Firms either accept or reject the workers proposal. If the

rms accept, they hire et units of labor at the wage wt . The industry also

colludes on investment. 14

The sub-game perfect Nash equilibrium of this game is constructed as

the limit of the bargaining game played a nite number of periods within

an individual industry. In this case, the rms strategy in equilibrium is to

accept any wage and employment offer ( w, et ) that yields a reservation level

of prots.

7.0.2. Cartel Problem

I rst dene the prot function as a function of the wage rate for the

monopolist in one of the cartelized sectors. To keep the notation simple, I

drop the industry ( i) subscript for the time being. The monopolists prot

function, conditional on capital stock k, is (k),and the associated optimal

employment function is e(k) :

(k) = maxe

Y 1 Y m he k1 we + (1 )k , (13)

14 Firms and workers bargain over the number of employees and the wage, but not hours

per worker. This makes the contract much simpler, and is also consistent with the adoption

of the 40 hour workweek through the Fair Labor Standards Act in 1939.

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where e(k) = e, and Y m is manufacturing output used in nal goods produc-

tion. 15

I now use this prot function to construct the industrys reservation prot

function, which is the outside option to the industry of rejecting the unions

offer. To do this, note that there are two payoffs to industry collusion, a

static payoff, which is the payoff from exploiting market power in the current

product market, and a dynamic payoff, which is the payoff from the industry

colluding on investment. The static payoff is ( w, k1). The returns that the

rms in the industry earn from colluding on investment is P 2 :

P 2 = maxes ( i ) ,k s ( i )

1ks (i) +Y 1 Y s [hes (i) ks (i)1

]

+(1 )ks (i)) wes (i)(14)

subject to

Y 1

Y

s hes (i))

ks (i)1 1

hks (i)es (i)

1

= w,

Thus, the total payoff is the sum of date t monopoly prots and invest-

ment collusion, ( k1) + P 2(k ), where k1 is the current level of the capital

stock. This implies that the total expected gross return to the rm from

rejecting the union offer is:

P 1(k1) = (1 )(k1) + P 2(k ) + (1 )k1 k ,

15 The functions for t and N t also depend upon Y, Y m and r t , but that is captured by

the time dependence of the functions.

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The rst term on the right hand side is the prot from paying the spot market

wage, scaled by the probability that a strike does not shut down production.

The second term is the payoff from colluding on investment, and the third

term is the payoff from shutdown, scaled by the probability of shutdown.

P 1(k1) thus denes the reservation prots that the rm must earn from any

union offer. In equilibrium the workers will offer a wage-employment pair that

yields a return that is equal to this reservation level: ( k1, w1, e1) = P 1(k1)

Recursively, this is given by:

P (k) = (1 )(k) k + P (k ) + (1 )k,

where k denotes the level of the capital stock that the rms in the industry

will choose. This will be the capital stock along the equilibrium path since

the workers will always offer (w, e) such that the rms earn their reservation

prot level, and thus weakly prefer accepting the offer (see Cole and Ohanian

[32]).

7.1. The Insiders Problem

The insiders offer a wage/employment pair at each date that maximizes

the present discounted value of rents per worker from the cartelized sector,

subject to the reservation prot constraint. 16 This value depends on the

16 I assume families are large enough to smooth out a family members employment

risk, but are small enough to work in only an arbitrarily small fraction of the industries.

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existing stock of workers in the industry at the beginning of the period and

the capital stock. We denote the existing number of workers in the industry

at the beginning of the period by e, which is equal to the number of workers at

the end of the previous period multiplied by the probability that the workers

remain in that industry:

et = e t 1

We denote the number of those who work in the cartel that period by e. If

e < e, then e e of the workers are randomly chosen to leave the industry. If

e > e, then the union adds members using a lottery. Given P, the solution to

the cartel workers problem is implicitly determined by the following Bellman

equation in which V (e, k) denotes the expected value of being a cartel worker

(relative to working in the competitive sector), in which there are e workersin the industry at the beginning of the period, and k units of capital in place:

These assumptions imply that the family is risk neutral with respect to the employment

outcome of any individual family member. Moreover, this implies that the family does

not internalize the aggregate consequences of their actions since the likelihood of a family

member obtaining a cartel job is independent of the actions of the industries in which

family members work.

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bers survival probability ( )17 I choose such that the union wage is 25

percent above trend, which is a conservative choice relative to estimates of

union wages relative to trend at that time. The implied value of is about

0.8. I am unaware of any specic estimates of the likelihood that a strike

would disrupt production. Dinardo and Hallock [33] analyzed major strikes

between 1925 and 1937 and classied whether the strike was won by work-

ers, won by rms, or whether the result of the strike was a compromise

between the union and rm. They estimated that 50 percent or more of

strikes were either won by workers or there was a compromise. While the

implied value of in the model is higher than the unions win/compromise

rate estimated by Dinardo and Hallock, note that strikes that werent nec-

essarily considered to be won by labor will still impede production and lead

to losses for rms.

I choose a value for the probability of remaining an insider ( ) to yield

an expected job tenure of about 10 years. Job tenure data from this period

is limited, but the model expected job tenure is high compared to the fact

that about half of manufacturing jobs in the 1920s lasted 1 year or less (see

Jacoby and Sharma [34], and that mean completed duration of jobs at Ford

Motor company plants during the 1919-1947 period were less than half a year

17 I keep the same workweek length in manufacturing in the union analysis as in the

Hoover analysis.

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(see Whatley and Sedo [35]). Note, however, that this parameter does not

affect the steady state.

Table 3 shows the steady state values of the union model variables rela-

tive to those in the pre-Hoover steady state. Unionization generates a larger

depression than the Hoover program, with output, consumption and invest-

ment declining by nearly 40 percent. and aggregate hours declining by nearly

30 percent, representing a 54 percent decline in manufacturing hours, and an

11 percent decline in agriculture hours.

With the hold-up version of the model in place, I now assess the incen-

tive for rms to follow the Hoover plan. To do this, I compare the expected

present value of prots under the Hoover plan, beginning in 1929:4 and con-

tinuing through the terminal economy, to prots if rms dont follow Hoover,

but instead operate in the economy with the risk of unionization.

Prots in the model with the threat of unionization depends on the prob-

ability of unionization, . I therefore solve for the value for such that rms

are indifferent between following Hoover or deviating and risking unioniza-

tion.

This involves a tradeoff in that expected prots in the Hoover economy

are lower initially, but higher later compared to the economy with the risk of

unionization. I nd that rms choose to follow Hoovers program provided

that , the probability of the rms workers organizing, is 10 percent per

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year or higher. Thus, it is reasonable that rms would be willing to raise

real wages about 7 percent per year in order to avoid the signicantly higher

wages that a union would ultimately extract.

8. A Monetary Theory for the Depression

This section discusses the ndings within the broader context of the Great

Depression literature. The traditional explanation is that monetary con-

traction, which created deation and low nominal spending, is the cause of

the Great Depression. This conclusion has been reached by a number of

economists, including, Friedman and Schwartz [2], Lucas and Rapping [36],

Hamilton [37], Eichengreen [38], Bernanke [39], Bordo, Erceg, and Evans

[31], among many others. But any monetary explanation of the Depression

requires a theory of a very large and very protracted monetary nonneutral-

ity. Such a theory has been elusive because the Depression is so much larger

than any other downturn, and because explaining the persistence of such a

large nonneutrality requires in turn a theory for why the normal economic

forces that ultimately undo monetary nonneutrality were grossly absent in

this episode. That is, if the Depression is largely the result of monetary

forces, then the size and the duration of the monetary nonneutrality wereremarkably well outside estimates from any other period.

This paper provides such a theory for a large and protracted monetary

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nonneutrality. The nonneutrality is quantitatively large in the Hoover econ-

omy because Hoovers wage maintenance and work-sharing program reduces

steady state hours and capital stocks. The nonneutrality persists in this

model because it is a transition from a non-distorted steady state to the

Hoover distorted steady state.

There was little nominal wage adjustment in the rst two years of the

Depression, as industry publicly maintained nominal wage levels following the

Hoover meeting, and indicated that their adherence to wage maintenance was

indeed due to Hoover. Industry followed Hoover, despite Hoovers rejection

of several industry requests to Hoover to cut wages. And in addition to the

evidence presented here, Rose [40] compiles complementary evidence from

U.S. Chamber of Commerce archives that supports the thesis that Hoovers

program was a key factor in accounting for industrys maintenance of nominal

wages. This analysis thus provides a theoretical interpretation for Hamiltons

[37] view that deation is the central initiating force for the Great Depression.

While Hoovers nominal wage maintenance program has been previously

noted in the literature, including work by OBrien [16], Vedder and Gallway

[41], Bordo, Erceg, and Evans [31], and Cole and Ohanian [29], I am unaware

of other research that has provided a detailed accounting of how the program

affected industry, offer a theory for why rms followed Hoover, and conduct

a quantitative analysis of the Hoover plan within a growth model. The most

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closely related work is by Ebel and Ritschl [21] who present an analysis that

is thematically similar, with a focus on policy changes that fostered organi-

zation and bargaining power a the end of the 1920s. They discuss in detail

the Court decisions affecting unionization during this period, develop a wage

bargaining model, and interpret the Depression as a shift from individual

bargaining to collective (union) bargaining.

I am also unaware of other theories of nominal wage maintenance that

are consistent with the evidence presented here about Hoover and industrys

maintenance of nominal wages. OBrien [16] is perhaps the best known anal-

ysis of nominal wage rigidity during the Depression. He argues that industry

maintained nominal wage levels, despite their impact on prots, simply be-

cause rms viewed this action as being in their self interest for boundedly

rational reasons. But OBriens view is inconsistent with these data, which

indicate that rms did not prefer to maintain high nominal wages, but rather

did this only because of Hoovers program. Moreover, as Rose [40] notes,

OBriens theory is subject to a large free-rider problem, as any individual

rm would have a big incentive to cut wages.

9. Conclusion

The dening characteristic of the Great Depression is a substantial and

chronic excess supply of labor, with employment well below normal, and real

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wages in key industrial sectors well above normal. A successful theory of the

Depression must explain not only why the labor market failed to clear, but

why monetary forces apparently had such large and protracted effects. This

paper proposes such a theory, based on President Hoovers program that of-

fered industrial rms protection from unions in return for paying high wages.

Firms deeply feared unions at this time, reecting a growing union wage pre-

mium and a sea change in economic policy, including policies advanced and

supported by Hoover, that signicantly fostered unionization and enhanced

their bargaining power. Consequently, there was an incentive for rms to fol-

low Hoovers program of paying moderately higher real wages to avoid even

higher wages and lower prots that would come from unionization.

I conclude that the Depression is the consequence of government programs

and policies, including those of Hoover, that increased labors ability to raise

wages above their competitive levels. The Depression would have been much

less severe in the absence of Hoovers program. Similarly, given Hoovers

program, the Depression would have been much less severe if monetary policy

had responded to keep the price level from falling, which raised real wages.

This analysis also provides a theory for why low nominal spending - what

some economists refer to as decient aggregate demand - generated such a

large depression in the 1930s, but not in the early 1920s, which was a period of

comparable deation and monetary contraction, but when rms cut nominal

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wages considerably. 18

Presidents Hoover and Roosevelt shared similar goals of fostering indus-

trial collusion and increasing real wages and raising labors bargaining power.

Hoover accomplished these goals during a period of deation by inducing in-

dustry to maintain nominal wages, and by promoting and signing legislation

that facilitated union organization and that increased wages above compet-

itive levels, including the Davis-Bacon Act and the Norris-Lagaurdia Act.

Roosevelt accomplished these goals with the NIRA and the Wagner Act,

both of which raised wages well above competitive levels while increasing

industrial collusion.

The 1930s would have been a better economic decade had government pol-

icy promoted competition in product and labor markets, rather than adopt-

ing policies that extended monopoly in product markets and that set wages

above competitive levels.

18 Kendricks data shows that real output fell only around 3 percent in the early 1920s,

but real consumption and investment actually increased. Thus, the 1921-22 recession

largely reects a decline in government purchases, which partially reects the postwar

demobilization.

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Table 1

Real Non-Union Wages

(Nominal Wages Divided by CPI)

(1919 = 100)

Date Union Non-Union

1920 108 108

1921 125 101

1922 128 102

1923 131 111

1924 139 113

1925 138 108

1926 140 106

Table 2

Steady State of the Hoover Economy

Relative to Pre-Hoover Steady State

(Pre-Hoover Variables = 100)

Y C I H W m H m W a H a

72 72 71 80 107 61 68 92

Table 3

Steady State of the Union Model

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Relative to Pre-Hoover Steady State

(Pre-Hoover Variables = 100)

Y C I H W m H m W a H a

62 62 61 73 125 48 56 89

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Figure 1 - Industrial Output and Hours(Sept 1929 = 100)

40

50

60

70

80

90

100

110

J a n - 2 9

M a r - 2

9

M a y - 2

9 J u l

- 2 9 S e

p - 2 9

N o v - 2

9 J a n

- 3 0 M a

r - 3 0

M a y - 3

0 J u l

- 3 0 S e

p - 3 0

N o v - 3

0 J a n

- 3 1 M a

r - 3 1

M

Manufacturing Hours Manufacturing Output


56/68

Figure 2 - Manufacturing Employment and Hours per Worker(Sept 1929 = 100)

40

50

60

70

80

90

100

110

J a n - 2 9

M a r - 2

9

M a y - 2

9 J u l

- 2 9 S e

p - 2 9

N o v - 2

9 J a n

- 3 0 M a

r - 3 0

M a y - 3

0 J u l

- 3 0 S e

p - 3 0

N o v - 3

0 J a n

- 3 1 M a

r - 3 1

M

Manufacturing Employment Average Manufacturing Hours


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Figure 3 - Manufacturing Wages(Sept 1929 = 100)

80

85

90

95

100

105

110

115

J a n - 2 9

M a r - 2

9

M a y - 2

9 J u l

- 2 9 S e

p - 2 9

N o v - 2

9 J a n

- 3 0 M a

r - 3 0

M a y - 3

0 J u l

- 3 0 S e

p - 3 0

N o v - 3

0 J a n

- 3 1 M a

r - 3 1

M

Nominal Real


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Figure 4 - Real GNP - Data and Model(1929Q3 = 100)

70

75

80

85

90

95

100

105

1929Q4 1930Q1 1930Q2 1930Q3 1930Q4 1931Q1 1931Q2 1931Q3

Data Model


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Figure 5 - Real Consumption - Data and Model(1929Q3 = 100)

80

82

84

86

88

90

92

94

96

98

100

1929Q4 1930Q1 1930Q2 1930Q3 1930Q4 1931Q1 1931Q2 1931Q3

Data Model


60/68


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Figure 7 - Manufacturing Hours - Data and Model(1929Q3 = 100)

40

50

60

70

80

90

100

110

1929Q4 1930Q1 1930Q2 1930Q3 1930Q4 1931Q1 1931Q2 1931Q3

Data Model


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Figure 8 - Agriculture Hours - Data and Model(1929Q3 = 100)

80

85

90

95

100

105

110

1929Q4 1930Q1 1930Q2 1930Q3 1930Q4 1931Q1 1931Q2 1931Q3

Data Model


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Documents

Who or What Started Depression